While many of us dream about retiring, not having to work, and being completely independent with little responsibilities, others dread the thought of retiring: worrying that they will never truly be able to save enough to live independently. The good news is that the latter is totally avoidable if you make a conscious effort to start saving from a young age.

Besides diligently putting money away month after month, one of the hardest parts of making sure you’ve got enough cash stashed for retirement is choosing between investing in a pension or a provident fund.

What are they anyway and why should I care?

When you start a new job, you are often tasked with choosing between these two retirement fund types.  The good news is there is no wrong choice, only a more suitable and a less suitable one, depending on your specific profile and possible future needs.

Both pension and provident funds have been designed to help people make financial plans for when they retire. It’s a great way to save money;  just think about it – if you work from the age of 20 until you’re 65, you would have had 45 years to save toward your retirement. Upon retiring at 65, you could very easily still live another 25 (or more) years without that monthly salary coming in. And, if you consider the inflation rate and the additional costs associated with old age such as chronic medicine and more intensive health-care requirements, it’s easy to understand why saving for your retirement so important.

What’s the difference?

Pension funds: this is a the set monthly income that a retiree receives from the pension fund that they have contributed to during the course of their employment. Each employer normally has its own preferred pension fund that both the employer and the employee contribute to (normally each party contributes 7.5% of the monthly cost to company to the pension fund). However, don’t forget that not all companies offer retirement benefits so you may be contributing to the fund by yourself.

When retiring, someone with a pension fund will be able to cash out one third of the total sum housed in the pension fund as a once-off pay out, while the other two thirds are re-invested in an annuity that pays a fixed monthly amount (much like a salary). The first R300 000 of the capital within the pension fund is tax exempt, thereafter income tax is payable.

Provident funds: by contrast, this fund is more flexible, allowing you to instantly access as much of the lump sum as you wish. Like with the pension fund, a portion of the income from this amount will be tax free. Once you exceed this amount you will have to pay income tax much like with a pension fund.

Since part of the income accumulated from a provident fund is tax free, the provident fund member cannot claim tax benefits while contributing to the fund as he or she will benefit from the tax exemption when cashing out the fund in the future.

Decisions, decisions…

The more popular of the two options, a pension fund, is best suited for impulsive people who love doing things spontaneously as well as to those of us who would like our money managed for us, allowing us not to worry about which investments to make and giving us the peace of mind that we will receive a set amount monthly for the foreseeable future.

On the other hand, a provident fund is ideal for the educated individual who wants to be the master of his or her own destiny. With a bit of know-how, you could invest in something that offers you a larger monthly return on investment than a pension fund can.

Ultimately, the choice is yours. And like we said, you can’t go wrong regardless of what you choose.